15-Aug-2014 10:15 AM

Cebu Pacific Air turns record profit in 2Q2014 as domestic market rationalises and yields improve

Analysis

Cebu Pacific Air has reported a record net profit of PHP3.014 billion (USD68 million) for 2Q2014 as both yields and load factor improved. It marks Cebu's highest quarterly profit since the Philippine LCC became publicly traded in 2010 - an impressive achievement given profits of nearly every other airline in Southeast Asia slipped in 2Q2014.

Domestically Cebu Pacific has benefitted from consolidation in the Philippine domestic market. Competitors have cut capacity, resulting in double digit improvements to yields and the return of rationality in a market which had suffered from an extended period of unsustainable fare wars. Cebu's domestic market share exceeded 60% for the first time in 2Q2014.

The Philippine international market remains highly competitive but Cebu Pacific's widebody operation is now in the black. Cebu Pacific also now has potential opportunities to expand in the regional international market as its biggest competitor, Philippine Airlines (PAL), makes adjustments.

Summary

Cebu Pacific Air reported a record net profit of PHP3.014 billion (USD68 million) for 2Q2014, marking its highest quarterly profit since becoming publicly traded in 2010.
The airline has benefitted from consolidation in the Philippine domestic market, with competitors cutting capacity and resulting in double-digit improvements to yields.
Cebu Pacific's domestic market share exceeded 60% for the first time in 2Q2014.
The airline's widebody operation is now profitable, and it has potential opportunities to expand in the regional international market.
Yields were up across both the domestic and international sectors, with average yield per passenger increasing by 13% in 2Q2014.
Cebu Pacific's long-haul unit is now profitable, and the airline plans to expand its fleet by 12 aircraft over the next three and a half years.

Cebu Pacific has its best quarter ever

Cebu Pacific reported significantly better than expected earnings on 13-Aug-2014, beating by a wide margin financial analyst expectations.

The second quarter is typically the best quarter for Philippine airlines and all Philippine carriers benefitted this year from the shift of Easter to April. But Cebu's profit figures were much higher than anticipated, particularly as it followed an 86% reduction in profits in 1Q2014 and disappointing losses in 3Q2013 and 4Q2013.

See related reports:

The net profit figure of PHP3.014 billion (USD65 million) is more than 10 times higher than the PHP257 million (USD6 million) profit from 2Q2013 while Cebu's operating profit (EBIT) of PHP2.449 billion (USD56 million) represents a 61% improvement compared to 2Q2013.

Cebu Pacific has delivered a net margin of 20.2% and operating (EBIT) profit margin of 16.4%, which should put it at the top of the list among all publicly traded airlines in Southeast Asia and possibly all of Asia-Pacific (some airlines have not yet reported their 2Q2014 results).

Cebu Pacific financial highlights: 2Q2014 vs 2Q2013 and 1H2014 vs 1H2013

Passenger numbers were up 19.7% in 1Q2014 to 4.7 million while seats were up 17.8%, resulting in a 1.4ppts improvement in seat load factor to 88.2%. Cebu Pacific says this marked its highest quarterly seat load factor since 2Q2011.

Cebu Pacific passenger figures and seat load factor: 2Q2014 vs 2Q2013 and 1H2014 vs 1H2013

Cebu's load factor on an RPK/ASK basis, however, slipped slightly to 84.8%. ASKs were up by 28.3%, driven by the Oct-2013 launch of services to Dubai, Cebu's first long-haul route, while RPKs were up 27.6%.

Cebu Pacific records significant yield improvements

Most importantly yields were up across both the domestic and international sectors. Cebu Pacific reported a 13% improvement in average yield per passenger in 2Q2014, which includes a 14% increase in average fares and a 6% increase in average ancillaries. Cebu Pacific executives said during a 14-Aug-2014 analyst call that domestic yields were up in the "mid teens" while international yields, excluding the Manila-Dubai route, were up by 7% to 8%.

Cebu Pacific is confident the encouraging yield trends seen in 2Q2013 will continue in 2H2014. The carrier's executives expect domestic yields to again be up in the low to mid teens on a year over year basis (on a quarter over quarter basis there will likely be a drop as the second quarter is typically the strongest).

Cebu Pacific expects short-haul international yields will be up in the high single digits in 2H2014, driven by Japan. The LCC has expanded significantly in Japan in recent months, upgrading Osaka to daily and launching Nagoya and Tokyo Narita. Japan delivers higher average fares than other regional international markets, pushing up overall yields. Excluding Japan Cebu Pacific expects slightly lower yields in the regional international market as competition across most of its short-haul international markets remains intense.

In the long-haul market Cebu Pacific executives expect higher year over year yields on Dubai in 2H2014. But they acknowledge average yields will be impacted by promotional activity on the new Kuwait and Sydney routes, both of which will be launched in Sep-2014.

The generally favourable yield picture is a stark contrast to the rest of Southeast Asia, where airlines continue to experience pressure on yields and have had to engage in deep discounting to maintain load factors. Cebu Pacific is still feeling similar pressures on some regional international routes but overall market conditions, particularly domestically, have improved significantly.

Total revenues were up 34% in 2Q2014 to PHP14.953 billion (USD340 million), outstripping the 27.6% increase in RPKs and 19.7% increase in passenger numbers. The top line growth was driven by a combination of organic expansion, including the launch of widebody operation in mid-2013, and the acquisition of Tigerair Philippines, which was completed in Mar-2013 and accounted for almost 7% of total revenues in 2Q2014.

Tigerair Philippines turns the corner

Cebu Pacific executives said during the analyst call that Tigerair Philippines, which was highly unprofitable during its time as an affiliate of the Singapore-based Tigerair Group, was able to make a positive contribution in 2Q2014. Tigerair Philippines currently operates 14 routes with a fleet of four A320s, which have been subleased from Cebu Pacific and have replaced a fleet of five A319/A320s which have been returned to the Tigerair Group.

Cebu Pacific has been able quickly to turn around Tigerair Philippines by rationalising its network, improving aircraft utilisation levels, boosting yields by selling flights through the Cebu Pacific distribution system (including the Cebu Pacific website) and reducing costs by leveraging Cebu's existing contracts and scale. Tigerair Philippines' average seat load factor was 82.9% in 2Q2014, putting it below the 88.2% seat load factor for the overall group but well above the load factor the carrier was achieving when it was part of the Tigerair Group.

Tigerair Philippines operating highlights: 2Q2014

Cebu Pacific executives are planning to allocate a fifth A320 to Tigerair Philippines in Dec-2014, allowing it to expand its domestic schedules for the northern winter peak season. Cebu Pacific plans to retain two air operator's certificates as it is now in the process of renewing the Tigerair Philippines AOC and congressional licence.

After this process is completed Cebu Pacific is expected to look at a rebranding. At least for now the group does not have any issues with continuing to use the Tigerair brand and believes the rapid turnaround of Tigerair Philippines shows the two-brand model works.

Cebu Pacific's A330 operation is now profitable

Cebu Pacific executives also said the carrier's widebody operation was profitable in 2Q2014. This includes profits on the domestic and short-haul international flights which Cebu Pacific has up-gauged from A320s to A330s as well as a very small profit on the carrier's only long-haul route, Dubai. Cebu Pacific reported an average load factor of 80.4% on the Manila-Dubai route for 2Q2014. This marks a significant improvement over the 60.1% load factor in 1Q2014.

The profitability of Cebu's long-haul unit is clearly one driver in the better than expected profit. The A330 operation, particularly the Dubai route, dented profitability in 2H2013 and 1Q2014. The prospects and outlook for Cebu's long-haul unit were analysed by CAPA earlier this week in a comprehensive two-part series of reports.

See related reports:

While a positive contribution from the long-haul unit and Tigerair Philippines clearly helps, almost all the profits in 2Q2014 came from the Cebu Pacific short-haul operation. The biggest improvement came in the domestic market, which accounts for nearly 80% of Cebu's passenger traffic although the carrier has diversified in recent years by pursuing more rapid growth in the international market.

In recent months Cebu Pacific has been enjoying encouraging yield, load factor and market share improvements in the domestic market.

Cebu Pacific's domestic market share now exceeds 60%

Cebu Pacific surpassed the 50% domestic market share threshold for the first time in 2013, when it captured 50.4% of the domestic market based on Philippine CAB data. Cebu's domestic traffic increased by 8% in 2013 to 10.2 million passengers while the overall market shrank by 1% to 20.3 million, driven by reductions at the PAL Group. Cebu's market share increased in 1Q2014 to 55.8%, including 51.6% for the Cebu Pacific brand and 4.2% for newly acquired Tigerair Philippines (based on Philippine CAB data) as the total market again shrank slightly driven by reductions at the PAL Group.

The Philippine CAB has not yet released traffic figures for 2Q2014 but Cebu Pacific estimates it captured 61.6% of the domestic market in 2Q2014, including a 55.3% share for the Cebu Pacific brand and 6.3% for Tigerair Philippines. Cebu Pacific estimates that the PAL Group's share of the domestic market slipped to only 27.3% in 2Q2014, including a 1.1% share for PAL mainline and a 26.2% share for regional subsidiary PAL Express, while AirAsia accounted for 11%.

Based on official Philippine CAB data, PAL Group captured a 32% share of the domestic market in 1Q2014 while AirAsia captured 11.5%. As CAPA previously noted, the PAL Group's domestic market share has steadily slipped since 2005, when it captured a 63% share. In 2013 the PAL Group captured a 34% share of the domestic market, including 35% in 1Q2013.

Cebu Pacific recorded steady domestic market share gains from 2005 to 2009 and overtook PAL in 2008 as the largest player in the Philippine domestic market. After reaching a 49% share in 2009, Cebu's share dipped slightly in 2010 and 2011 as LCC competition increased, driven primarily by expansion at Zest and AirPhil as the overall market grew both years at double digit clips. Cebu Pacific was again able to slightly increase domestic market share in 2012, from 45% to 46%, as Zest retreated slightly while Tigerair Philippines and Philippines AirAsia (PAA) entered the market.

Cebu Pacific domestic market share (% of passengers carried): 2004 to 2Q2014

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Cebu Pacific benefits from domestic consolidation as PAL redirects its attention to international routes

Cebu's acquisition of Tigerair Philippines, which was initially announced in early Jan-2014, marked the end of a period of significant but needed consolidation in the Philippine aviation market. PAA and Zest forged a tie-up and equity swap in early 2013. Zest later adopted the AirAsia brand and the two carriers have since been integrated.

Also in early 2013 the PAL Group transitioned AirPhil, now known as PAL Express, from an LCC to full-service regional carrier. In the process the PAL Group reduced domestic capacity as it abandoned its prior strategy of using both brands to cover trunk routes.

While competition remained intense and irrational for most of 2013 signs of more rational behaviour started emerging in early 2014. As CAPA suggested in Jan-2014: "The outlook for 2014 is rather bright as Cebu Pacific's acquisition of Tigerair Philippines leaves only two competitors... With just three players in the domestic market, irrational competition is unlikely to return."

With the playing field whittled down from six to three players the Philippine domestic market is clearly enjoying a new equilibrium that other major domestic markets in Southeast Asia are still struggling to reach due to intense competition and overcapacity. Further improving market conditions, Cebu's two remaining domestic competitors have further cut domestic capacity so far this year.

The PAL Group further reduced its domestic presence in early 2014 as it withdrew the PAL brand almost entirely from the domestic market. PAL Express has expanded, but not enough to offset the reduction at PAL mainline. The focus at PAL has turned to the international market, where the group recorded 22% passenger growth in 1Q2014 (data for 2Q2014 is not yet available).

AirAsia also has been reducing its focus on the Philippine domestic market in favour of a stronger international presence as part of a restructuring which is aimed at turning around the group's Philippine operation, which so far has been highly unprofitable. AirAsia domestic capacity in the Philippines (PAA and Zest) is currently down by about 30% compared to Aug-2013 levels, according to CAPA and OAG data.

Cebu Pacific meanwhile has pursued relatively modest domestic expansion, particularly in light of the rest of the market shrinking, allowing it to boost yields and load factors. Cebu Pacific currently operates about 2,000 weekly domestic flights (including about 250 at Tigerair Philippines) on 59 routes to 34 destinations.

With its only remaining LCC competitor (AirAsia) no longer focusing on the domestic market, Cebu Pacific should be able to enhance its leading position. Even if the PAL Group looks to restore some of the domestic capacity removed over the last couple of years, Cebu Pacific enjoys a very strong position as it is now more than double of the size of PAL domestically. PAL does not have the scale or cost structure of Cebu Pacific. The latter is particularly important as the Philippine domestic market is extremely price sensitive with limited premium demand.

Cebu Pacific has effectively beaten back all domestic competitors and weathered the storm. While expansion from the two remaining competitors or the entrance of a new competitor cannot be ruled out, a repeat of the market conditions from the last two years is unlikely.

Cebu Pacific faces a tougher road in the international market

The international market presents more challenges and risks for Cebu Pacific. PAL particularly has been aggressive, expanding in virtually every international market targeted by Cebu Pacific including Australia, Guam, Hawaii, Japan, Saudi Arabia and the UAE. (Cebu Pacific has not yet entered Australia, Guam, Hawaii or Saudi Arabia but is planning to begin services in these markets over the next six months.)

But PAL recently retreated in Japan, in May-2014 dropping one of its two daily flights to Tokyo Haneda and from late Sep-2014 one of its three daily flights to Tokyo Narita. Cebu Pacific is now seeking to take over PAL's unused Haneda rights and could also eventually look to add a second frequency to Narita (although for now it is satisfied with maintaining the one daily frequency launched in late Mar-2014). Cebu Pacific is also seeking unused Filipino carrier rights to Taipei, where it aims to add capacity beyond its current one daily frequency.

PAL could make further adjustments following potential changes to the group's ownership structure. Cebu's overall outlook, particularly for the international market, still largely hinges on what transpires at PAL.

Cebu Pacific's outlook brightens as market conditions improve

Cebu's domestic position has certainly improved over the past year, as evidenced in the record profit for 2Q2014. The Tigerair Philippines acquisition has provided additional slots at congested Manila and enabled Cebu Pacific to further grow its already leading share of the domestic market. The deal also knocked out a domestic competitor, concluding a period of dramatic consolidation which has clearly benefited Cebu Pacific.

Cebu's international strategy is still very much a work in progress but the long-haul unit is now profitable and providing strategically important growth. Cebu also has opportunities to expand its regional international operation, particularly to North Asia where competition is not as intense compared to routes within Southeast Asia. The new widebody operation will also play an important role in regional international growth as it can provide feed, using new long-haul routes such as Sydney, as well as take over some short-haul routes to high demand slot constrained destinations.

Unlike some other LCCs in Southeast Asia Cebu Pacific is not overly ambitious and has a relatively conservative fleet plan with 43 aircraft on order. Over the next three and a half years the total size of the group's fleet is planned to grow by only 12 aircraft from 50 to 62 units.

Cebu Pacific group fleet plan: mid-2014 to end 2017

Much of Cebu's growth over the next several years will come from upsizing as it takes more A330s, phases out A319s and receives A321neos. This is a sensible strategy given the capacity constraints at Manila. The inability to add flights at Manila is a challenge and a benefit as Cebu Pacific is now the market leader.

Nothing is a sure bet in today's turbulent Southeast Asian aviation industry. But its impressive 2Q2014 results could be an indication that Cebu Pacific has become the first airline to negotiate the storm clouds.